Keep A Steady Hand On The Tiller

I hope this finds everyone still enjoying a nice end to the summer and, importantly, avoiding the day-to-day in the financial press.

If you’ve happened to look, however, you will have seen and heard quite a few headlines from last week that might raise concerns. The following are some examples:

“If your pension, retirement savings or 401k is invested in the stock market, you lost big today”

“The stock market plunges and drops 530 points and more than 1000 points for the week”

First, remember that the financial media thrives by writing colorful headlines, which draw eyeballs and hence sell advertising.

It has been a crazy few weeks for investors though.

China’s stock market – after one of the biggest run-ups in history – has dropped approximately 40% in just a few weeks. Greece is still in the news with the talk of new elections, and oil and other commodities are also down sharply.

What should an investor do?

Well, the best advice might have come from my 10 year old son, Jack, when last Friday night (the day of the 530 point drop in the stock market) he was telling me about his day on the water in sailing class. He said, “Daddy, today the wind was strong and it was a little scary at first. I remembered what my teachers said though, kept calm and just stayed on course.”

Staying composed when storm clouds bring bad weather is not easy but, just as keeping a steady hand on the tiller and staying calm is the key to reaching a port safely, avoiding the urge to make changes in volatile markets is the key to long-term investing success.

Over the years, I’ve written many commentary pieces after market falls (it seems that concerns over 50 year floods come every 5 years or so in the stock market) and my message is always the same.

Make sure you have a solid long-term plan (emphasis on long-term) that is prudently diversified and designed to meet your goals, not the investment models of others.

I know it is hard to avoid getting emotionally drawn in by market headlines but try to remember that investing should be a means to an end, not a competition.

Try to stay anchored on your plan versus getting caught up in the day-to-day.

This is very difficult, by the way, and many investors make poor decisions at the wrong time.

Earlier this year, Morningstar published a report that looked at the difference between the average return of mutual funds and the actual returns of investors. According to their research, the 10 year return of the average U.S. equity fund for the period ending 12/31/13 was 8.18%. What was the average return of U.S equity fund investors over this same time period? Unfortunately, only 6.52% (click here for the full report and see the below chart).


As John Rekenthaler from Morningstar wrote, “Investors tend to get in and out of an asset class at the wrong time.”

If you believe that this 10 year period was an outlier, you can look at research from the institutional investment consultant DALBAR. The findings showed that investors have underpeformed the market by approximately 4.2% per year over the past 20 years (click the following, “ Bad Decisions Persist After Decades of Education and Disclosures ” to read the full whitepaper).

What can we do to be better investors?

If you do not already have a written Investment Policy Statement (IPS) or long-term plan, consider getting one.

At Fiduciary Wealth Partners (FWP), we work with clients to help set long-term investment goals, and establish risk, liquidity and asset allocation targets designed to meet these objectives before we invest. It has been our experience that, if you write down goals before investing, it is easier to stick to a plan versus letting emotion, or the competition of the market, take over.

FWP believes that an IPS should set long-term targets for various asset classes and maximum and minimum risk control ranges around the targets. This way, regardless of the emotion of the market, you can keep yourself from making big bets that can turn into big mistakes.

As an example, a moderately risk-adverse investor might consider having a long-term target of 60% in equities with a low end range of 50% and a high end range of 70%. If the market drops significantly and the equity allocation goes below the minimum range, the IPS mandates that an investor buy. On the other hand, if the market has run up significantly, the maximum IPS ceiling forces selling to take some chips off the table. We recommend reviewing allocations and rebalancing back to long-term targets quarterly.

I certainly do not know how this current market will unfold over the next few weeks or months, but sticking to a disciplined plan is the key to investment success. The old saying is, “Strategies don’t blow up, people do.”

Beyond the Morningstar or DALBAR research mentioned above, one of the best examples of potentially lost opportunities might be from the 2008-2009 financial crisis. In March 2009 the S&P 500 hit the “world is going to end” level of 666. If you had an IPS in place, and someone to help you stick to your written plan (it is hard to keep emotions in check on your own), you would have found yourself below your minimum allocation target to equities and would then have bought equities at the end of the quarter to rebalance back to your long-term target.

Even after what the financial press is currently calling “a rout”, the S&P 500 closed yesterday at 1,970. A gain of over 195% over from the 666 low in 2009.

To help “keep calm and carry on”, below are a few simple recommendations to consider.

Have A Long-Term Plan That Is Designed to Meet Your Individual Goals
- Investing should not be a competition
- Unless your goals have changed, do not throw out a good plan with a bad market

Set Investment Policy Max. and Min. Ranges For Various Types of Investments
- Everyone will be wrong from time to time
- Set limits on the upside and downside before you invest
- Max. and Min. ranges should help to control emotions and hence risk

Try to Think Outside the Box and Consider Being Contrarian
- Wall Street predictions are often wrong (see our “ If We Had A Chief Economist We Would Have To Pay Them ” blog)
- Large flows into and out of an asset class are often a sign of a top or bottom

Place a Premium on Liquidity
- Don’t invest in illiquid investments unless the rewards being offered are compelling
- Don’t blithely pay higher fees for lower liquidity
- Carefully evaluate return and risk opportunities being offered when taking on illiqudity

Understand True Risk Exposures of All Investments
- High yield and emerging market bonds and distressed debt don’t have the same risk as other bonds
– Fancy alternative strategies based on complex models and investment theories may not hold up when you need them the most (remember Long-Term Capital)

Remember Taxes and Fees
- Keep-it-simple, low fee investments often outperform (see our “ Stay It Ain’t So, Joe ” commentary on active funds versus index strategies)
- Complex hedge funds that promise high returns or downside protection are often very tax ineffecient (see our “ What Would Yale Do If It Was Taxable ” piece on how index funds are often more appropriate for taxable investors)

Don’t Be Sold
- If you don’t full understand it, don’t buy it
- Always ask for complete transparency on all fees, risks and conflict.

Slow, Steady and Boring Often Wins
- As with many things, the tortoise consistently beats the hare and often with much more peace of mind and less heartburn, which makes it easier to stick to a long-term plan.

As my son has learned on the water this year, conditions are often out of our control and can change rapidly. Be prepared and stay broadly diversified. Don’t reach for returns. Keep focused on your long-term plan and don’t be sold the hot investment strategy. Staying with the boating theme, and an old tried and true saying, make sure your “ventures are not in one bottom trusted” (Merchant of Venice – Shakespeare).

This past week brought market storms, but remember, history consistently teaches us that true long-term investors (who will in practice come in for the most criticism – John Maynard Keynes) will continue to be rewarded for keeping a steady hand on the tiller.